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Maintaining Authority Compliance in Your Chinese Subsidiaries: - A Guide to Meeting The Challenge

In recent months many foreign companies have experienced an increased scrutiny of their subsidiaries in China. This coincides with the recent years of slowdown in the Chinese economy in general. In the absence of a systematic method of securing authority compliance, a company runs the risks of being exposed to high fines and loss of production time. In some instances where the infraction may be deemed extreme it may lead to the detention of the legal representative.

Asia Base Law & Projects (Suzhou) Co. Ltd.

In recent months many foreign companies have experienced an increased scrutiny of their subsidiaries in China. This coincides with the recent years of slowdown in the Chinese economy in general.

A seeming increase in levels of aggression has been reported on the part of Tax Authorities who are believed to be constrained to find additional sources of revenue. Similar levels of intensity are observed in respect of the Administration of Industry and Commerce, which has reportedly become more active in identifying and investigating incidence of non-compliance and imposing fines where breaches are discovered. Not to be outdone is the State Administration of Foreign Exchange which is perceived to have become more stringent in its dealing with overseas payments in foreign currency.

The Challenge of Maintaining Compliance
In addition to the concerns highlighted above, data shows that companies have had experiences of varying degrees of difficulties with maintaining authority compliance in relation to the various authorities with which the subsidiary must interact. To exacerbate the concern is the fact that these experiences are not only inconvenient, they are sometimes unpleasant. Moreover, the legal and regulatory framework may at times change in a manner that appears to be ad hoc making compliance genuinely difficult.

Just recently, the manager of a large European Corporation was detained by local Chinese police pending the clarification of a matter involving authority compliance. In that instance, a product was added to an existing portfolio of industrial components. Noteworthy is that up until this point, there were apparently, no compliance issues. Furthermore, the added product was merely a larger model of the same type of product which was already being produced. However, the relevant checks were not made which would have highlighted the fact that a special “production license” was required for the larger model. Therefore, one decision resulted in the company going outside the scope of its existing, approved business scope, therefore losing its authority compliant status. During an inspection the infraction was discovered resulting in the detention of the company’s legal representative. His release was not secured until a significant sum was paid as a fine and the disruption in service which was experienced is hard to quantify.

The Impact of Failing to Meet Challenge of Authority Compliance
The experience of the company as documented above, is by no means novel or unique. Rather, it speaks to the absence of a systematic approach to compliance documentation in relation to new products, a situation which exists in many China subsidiaries.

In the absence of a systematic method of securing authority compliance, a company runs the risks of being exposed to high fines, loss of production time and in some instances where the infraction may be deemed extreme, leading to the detention of the legal representative. In other instances, even if there are no fines, financial losses are inescapable. This is not difficult to envisage when a company has one or more of the following experiences:

  • Problems with import and export due to missing registration documentation; 
  • Issues with obtaining loans and payments due to incorrect, incomplete or absent permissions; 
  • Problems with remittance of dividend and other inter-company payments due to lack of approvals or wrong approvals; 
  • Challenges with delivery due to missing production- or product licenses; 
  • Issues with insurance companies due to lack of documentation or outdated and/or expired policies; 
  • Human resources challenges due to missing or expired employment contracts;
  • Challenges with protecting Intellectual property rights due to absence of the relevant certification.

Meeting the Challenge of Authority Compliance: How?
The following example of a pragmatic approach to compliance assurance has been developed by Asia Base. It can be performed by a Company without excessive external assistance. Therefore, compliance need not be considered as an exercise to be dreaded on account of the cost factor.

The first step requires a detailed analysis of the industry requirements in relation to your business and what is necessary in order to meet compliance standards. At this juncture and certainly when this is being done for the first time, the services of a local law or accounting firm are indispensable to the provision of a solid, comprehensive perspective, informed by experience, in relation to what is required.

The second step involves the implementation of a comprehensive filing system under which required documentation may be divided into categories, for example as follows:

  1. Shareholder related documentation (this includes, but may not be limited to investor registrations, Power of Attorneys, appointment of board members, Legal Representative(s) and Supervisor (s));
  2. Company registration documentation (this includes but is not limited to, documentation showing compliance with company registrations, tax and customs registrations, approvals and licenses, capital injection and foreign loan registration); 
  3. Operation certificates & permissions (this includes but is not limited to, product registrations, production licenses, special licenses, approvals specific to industry, products, processes and environmental impact assessments); 
  4. Facility approvals and permissions (this includes but is not limited to, design approval, construction approval, equipment approvals, safety and hygiene approvals, utility approvals and fire approval); 
  5. Board of Directors file (this includes but is not limited to, resolutions and nominations); 
  6. Auditors book (this includes but is not limited to assignment contract, communication records and audit reports); 
  7. IPR documents (this includes but is not limited to, patents, trademarks, copyrights, license agreements and software licenses); 
  8. HR related documents (this includes but is not limited to, contracts of employment, contracts concerning independent contractors, social insurance, work permits, residence permits, visas, human resource manuals/policy documents and employee handbooks); and 
  9. Insurance cover (which includes, but is not limited to property and risks including 3rd party liability and Employer’s liability, motor vehicle insurance and product liability etc.)

The final step in this 9-pronged filing system is to review and ensure that each document required is (i) in existence, (ii) valid in terms of the timeframe which it covers, and (iii) up-to-date in relation to the information contained.

Admittedly this part of the process can also be exceptionally tedious, requiring checks and balances for over one hundred documents. To that end, the use of legal services may be prudent. Asia Base offers a standard compliance review package that to a large extent is able to identify a problem and secure resolution before it becomes an issue (See short video about Corporate Compliance at this link)

Meeting the challenge of authority compliance in China can be exceptionally difficult. The reasons for this are manifold but primarily relate to the manner in which regulations are made, applied and adopted. Indeed, a failure to meet compliance stipulations may result in significant financial losses. This however should not be viewed in an inhibitive manner by either potential market entrants or existing market players. Rather, the solution is the implementation of a systematic compliance system to weather the challenge.


This was the "Article of the Month" from our March Newsletter, sign up for the newsletter here